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There has been lots of talk about what the shape of economic recovery might be. We expect a “swoosh-shape”. Here’s why.
An alphabet soup of recovery possibilities exists
Our current forecast calls for a staggering 10% decline (peak-to-trough) in global growth (GDP) in the first half of 2020. Given the weakness of the data for March and April, the results could prove far worse. However, the pace of contraction is less important than the timing and magnitude of the recovery that follows. An alphabet soup of possibilities exists. Below we share brief views on each of the possibilities.
What is a “V-shaped” economic recovery?
“V”— Historically, most recoveries have been V-shaped, with activity returning to pre-recession levels in the same or less time as the duration of the downturn. Unfortunately, the current experience is unlikely follow this pattern. While the sudden halt to activity associated with national lockdowns triggered a steep descent into recession, the re-opening of economies will occur much more gradually, precluding a sharp ascent during the recovery phase that characterises a V-shaped rebound.
If the shutdown of the global economy is similar to a light switch being flipped off, the re-start will be more like a dimmer switch being gradually turned up.
What is a “U-shaped” economic recovery?
“U” — The clearest example of a “U” was the Global Financial Crisis (GFC). Over the course of 2008 and 2009, the contraction in real GDP became gradually more pronounced, and the subsequent rebound to pre-GFC levels in many countries took years.
As noted, the economic contraction triggered by the coronavirus has been sudden and sharp. This steep slope on the downside reduces the possibility of the current episode looking like a “U.” Similarly, on the upside, even a staggered re-opening will statistically generate a steeper ascent (off an extremely low base) than would be characteristic of a “U”.
What is a “W-shaped” economic recovery?
“W” — The so-called “double-dip”. Under this scenario, the economy contracts, recovers, and then falls back into recession – in this case, presumably due to a resurgence of the virus. While we certainly do not dispute the possibility, even probability, of renewed outbreak later this year, our assumption is that a “second wave” would be more manageable.
In addition to perhaps more widespread immunity, governments should be far better prepared. With expansive testing, better treatment, more medical supplies and hospital beds – this preparedness should hopefully eliminate the need for blanket restrictions to be reinstated. While we believe a “W” can be avoided, uncertainty surrounding coronavirus leaves us most concerned about the risk of this scenario.
What is an “L-shaped” economic recovery?
“L” – This pattern is the most pessimistic, and thankfully the most unlikely, in our view. Under this scenario, the level of activity drops almost vertically and then essentially flat lines over the course of several years. To be sure, the shuttering of global economies may deliver the initial down stroke. However, the sheer magnitude of the initial plunge (not to mention the unprecedented monetary and fiscal policy response) dramatically increases the probability that at least some pickup in activity will be seen this year. Moreover, the widespread closure of national economies cannot be sustained indefinitely; the economic cost and the social backlash would be too great.
A “tipping point” exists where the challenge for business shifts from short-term liquidity to long-term solvency and whether companies can survive in the face of curtailed activity. That window may be one to three months, after which either some rebound is seen or real GDP falls further. In other words, over the second half of 2020, the economy will almost surely be either growing or continuing to contract; it won’t be holding steady at low levels as depicted by an “L”.
What is a “swoosh/tick/italicised V-shaped” economic recovery? Our base case
“Italicised V” – That’s what we’re calling it, though. It’s also known as the “swoosh”. This is our base case – a steeper gradient on the downside, then a partial bounce, followed by a more gradual recovery. While the old adage “the larger the fall, the higher the bounce” is tempting to consider, the second-half rebound is unlikely to recoup all of the losses generated in the first half of 2020 (H1).
As you can see in the charts below, we expect all regions to see a “swoosh-shaped” rebound, with the US, Euro Area, UK and Japan’s recovery occurring simultaneously, though at different levels. China’s swoosh, due to their timing of the coronavirus, will occur slightly earlier.
A “swoosh-shaped” recovery is our base case
Why our base case calls for a “swoosh-shaped” recovery
We believe several factors will hinder the pace of recovery. On the consumer front, the economic damage that the virus has wrought – particularly with respect to employment and earnings — will have lingering effect. Even beyond the income hole created by temporary or permanent job losses, consumer behaviour will be changed. In our view, the re-opening of economies will not mean a quick return to “normal” — social distancing practices, ongoing concern over health, and the desire for greater precautionary savings will partially offset the release of pent-up demand.
On the business side, increased uncertainty over the outlook, post-crisis overcapacity (particularly in hard-hit sectors, e.g. airlines, hotels, energy), and high debt levels will restrain the rebound in capital spending. While output will surely bounce as the lockdowns are lifted, the case for a strong and sustained consumer- or business-led recovery is limited. In the UK, US, Euro area, and Japan, we expect large increases in real GDP in Q3 and Q4 (recouping a good portion of the output lost in H1) to give way to progressively smaller gains through 2021 — resulting in an “italicised V” or “swoosh-shaped” recovery (in China, the return to pre-virus levels is seen earlier).